A bull's eye view

Larry Kudlow
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Posted: Nov 27, 2003 12:00 AM

Far-away terrorism and some low-intensity trade disputes have temporarily stalled the stock market. But is the fledgling Bush boom coming unglued? Even when things look a bit ragged around the edges, there's still no reason to doubt the market, the economy or the political prospects for George W. Bush's re-election. Critics beware.

Currency mavens may rant and rave over trade deficits, but these phony and opaque numbers have nothing to do with currency value. The United States has strong political leadership, a strong foreign policy and strong economic growth. You want to buy yen or euros? Go ahead. It's a free country. But it's a sucker's bet. Buy dollars.

In fact, the cheapest currency in the world right now is the U.S. dollar. Watch the greenback strengthen significantly in the years ahead. High after-tax investment returns, breathtaking productivity gains, totally awesome profitability, virtually no inflation and historically low interest rates tell this tale. So do falling unemployment claims and rebounding manufacturing indexes. A University of Michigan think tank just predicted a 5.4 percent unemployment rate for 2004, a 4.8 percent rate for 2005 and 5.2 million new jobs over the next two years.

Of course, inflation worriers point to today's high gold price (gold is a proven inflation metric). But gold, now near $400 an ounce, is $50 too high. Money is not all that loose: The Federal Reserve is in a mild excess-reserve position, exactly where it should be as we turn from deflationary recession to reflationary recovery.

Today's gold rebound is driven by a combination of monetary reflation, huge commercial demands from China and a terrorist-related risk premium. But none of these are inflationary -- at least not significantly. Commodity indexes, meanwhile, are about where they were in 1996-97, when inflation was 2 percent or slightly less. The current inflation rate for consumers and producers is even less than that.

In short, there's not too much money out there. Supply-side guru Art Laffer opined recently that U.S. money is actually relatively restrained. Growth of the U.S. monetary base and the measure known as MZM (money at zero maturity) are about 6 percent, a modest rate that shows non-inflationary balance between cash supplied by the Fed and cash demanded by the economy.

Meanwhile, economic profits are rising about 25 percent, and productivity is ranging around 4 percent. These are awesome numbers for business expansion and efficiency. Along with a 35 percent rise in the S&P stock market since the mother of all bottoms last Oct. 9, it's clear that the investment and business bust is over. We are on the front end of an eight-to-10-year boom.

Members of the investor class should keep their eyes on the fundamental story. Low interest rates and rising earnings are still signaling a roaring bull market. Expected profits suggest that the stock market is at least 20 percent undervalued. A Dow Jones index over 11,000 is not out of the question for next year.

But again, no situation is ever perfect. The Bush administration's protectionist stance on trade is wacky. The steel tariffs were stupid, although they'll hopefully be repealed in the next few weeks. New import quotas on Chinese lingerie are more than stupid -- they're an embarrassment. But there will be no global trade war. Mischief-makers in the Commerce Department will be stopped well before the water's edge.

And in Laffer's words, reducing high marginal tax rates on dividends, capital gains, top personal incomes and business depreciation bonuses are much more important than low-grade trade disputes. These supply-side measures jolted the economy into true recovery.

Democratic pessimists on the campaign trail will get nowhere with the American people next year. The nine tax-hiking Mondales would wreck recovery. The antiwar McGovernites would undercut our domestic security and our international credibility. The president will stay the course in Iraq primarily to protect American safety -- and the United States will prevail.

With the economic winds at his back, and a steadfast no-cut-and-run policy in Iraq and other places where terror thrives, Bush will retain the confidence of the American electorate. If the Democrats had learned from Truman and JFK, they might have made it a real horserace. But they opted for the McGovern-Mondale model: an election-year loser. Bush should win next November with 42 states or more. And his coattails will increase legislative majorities in the Senate and the House.

Hopefully, in Bush's second term, we'll see some serious budget restraint and a better trade policy: We should grow our exports, not erect barricades against imports. Personal Social Security accounts, new super-saver plans for retirement, health and education, and thorough-going tax reform should also be on the post-election agenda.

Leave pessimism to the traditional old-media outlets. It doesn't matter what they preach. This country is in good shape.